Will Currencies Be The Next Lehman? Einhorn's Speech (Dollar, Euro, Pound, Yen, Gold)

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With all of the money printing going on globally, many people believe there will be a currency crisis and eventually a repricing of sovereign debt risk (US Treasuries priced in US Dollars, JGBs in Yen). Lets not forget the aggressive currency players betting on a prolonged period of 0% interest rates by shorting US Dollars and putting on carry trades (selling lower yielding dollars for higher yielding currencies BRL, AUD). So there are definitely people trying to profit off of the demise of purchasing power. Kind of reminds me of Lehman shorts and CDS holders pre-bankruptcy. Commodities investor Jim Rogers has been warning about a currency crisis for a while now (see his CNBC interview on June 16.).

So now hedge fund manager David Einhorn of Greenlight Capital, who publicly shorted Lehman before it's demise, is positioning for a currency crisis by buying gold. He's not singling out the US Dollar either, he doesn't have faith in the Yen, Euro or Pound. The full speech PDF is available at Rolfe Winkler's Reuters blog post. Interesting points he made:

"I believe there is a real possibility that the collapse of any of the major currencies could have a similar domino effect on re-assessing the credit risk of the other fiat currencies run by countries with structural deficits and large, unfunded commitments to aging populations..."

"I have seen many people debate whether gold is a bet on inflation or deflation. As I see it, it is neither. Gold does well when monetary and fiscal policies are poor and does poorly when they appear sensible. Gold did very well during the Great Depression when FDR debased the currency. It did well again in the money printing 1970s, but collapsed in response to Paul Volcker’s austerity. It ultimately made a bottom around 2001 when the excitement about our future budget surpluses peaked.

Prospectively, gold should do fine unless our leaders implement much greater fiscal and monetary restraint than appears likely. Of course, gold should do very well if there is a sovereign debt default or currency crisis..."

"....When I watch Chairman Bernanke, Secretary Geithner and Mr. Summers on TV, read speeches written by the Fed Governors, observe the “stimulus” black hole, and think about our short-termism and lack of fiscal discipline and political will, my instinct is to want to short the dollar. But then I look at the other major currencies. The Euro, the Yen, and the British Pound might be worse. So, I conclude that picking one these currencies is like choosing my favorite dental procedure. And I decide holding gold is better than holding cash, especially now, where both earn no yield.

Along these same lines, we have bought long-dated options on much higher U.S. and Japanese interest rates...."

He was right about Lehman and the bond insurers, so keep an eye on gold. He did say he could be wrong if "our leaders implement much greater fiscal and monetary restraint" (Volcker style interest rate policy). But he's been right more than he's been wrong... We shall see!

Medical Marijuana Inc. MJNA Up On Obama's Medical Marijuana Guidelines (Videos, Press, Charts - 10/19/09)

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I don't usually look at penny stocks but today is the exception. Medical Marijuana Inc. (MJNA) and Cannabis Science (CBIS) popped today on Obama's new medical marijuana guidelines: Medical Marijuana Policy Eased by Justice Department (Bloomberg).

"Oct. 19 (Bloomberg) -- The Obama administration is advising federal prosecutors not to seek criminal charges against those who use or supply marijuana for medical purposes in accordance with state laws".

Medical Marijuana Inc. (MJNA) is up 20% today at 0.32 last time I checked. Below I found an interview with the CEO. He might be high but he thinks it is the next Microsoft! Go to the website: Medicalmarijuanainc.com.

Also, "Breaking News: Cannabis Science (CBIS) Reports Obama Administration Issues New Medical Marijuana Policy; One More Step Toward Legalization As The Federal Government Won't Prosecute Medical Marijuana If Compliant With State Law" (Reuters/BusinessWire).

This is interesting.. Crime around medical marijuana dispensaries in Colorado. They should just legalize it. Maybe we will see Marijuana Farm REITs down the road.

Full disclosure: I do not have possession of Medical Marijuana Inc or Cannabis Science and there is no recommendation to buy marijuana stocks, or pot on this post.

CIT 3/2011 Bonds at $55, CDS 40bps, Icahn Offers $6 Billion Loan

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An update on the CIT Group mess... Icahn, the largest creditor is offering to underwrite a $6 billion loan. I also provided a view of the CIT Group retail note that matures on 3/15/2011. It is trading at $55 and yields 54.17%. View the quote and charts at FINRA.org's Bond Center. As of 7/16/2009 Moody's rates the bond at Ca and S&P CC. Looking at Markit's quotes, CIT Group CDS trades at 40bps up front.

CIT 3/2011 Note Price (Courtesy FINRA.org/Marketwatch)

Egan-Jones On Why Carl Icahn's CIT Overtures Are Irrelevant (Zero Hedge)
CIT’s Changes Do Little to Enhance Debt Swap, CreditSights Says (Bloomberg)
Icahn offers CIT Group $6 billion loan (AP)
UPDATE: Icahn Offers To Underwrite $6B Loan To CIT (WSJ)
Icahn Offers CIT $6 Billion Loan, Calls Board ‘Incompetent’ (Bloomberg)
Icahn offers CIT 6 bln dlr loan, blasts board (AFP)
The Daily Docket: CIT Amends Exchange Offer (WSJ/Bankruptcy Beat)
CIT Sweetens Exchange Offer (WSJ)
CIT Group Revises Debt Plan (NYT)
10/13: CDS On CIT Hover As Bankruptcy Looms (Derivatives Weekly/subscription)
10/5: If CIT fails, Goldman wins -- with a $1 billion payoff (DailyFinance)
10/5: CDS in the spotlight in Goldman purchase of CIT debt (Financial Times)

S&P, SPY Elliott Wave C, 50% Fibonacci Retracement Charts

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Robert Prechter uses the Elliot Wave Principle to determine market moves. He correctly called the March lows and is now predicting a wave lower based on momentum indicators, sentiment and the Elliott Wave principle (10/5 interview). What is it....
The Elliott Wave Principle
In the 1930s, Ralph Nelson Elliott, a corporate accountant by profession, studied price movements in the financial markets and observed that certain patterns repeat themselves. He offered proof of his discovery by making astonishingly accurate stock market forecasts. What appears random and unrelated, Elliott said, will actually trace out a recognizable pattern once you learn what to look for. Elliott called his discovery "The Elliott Wave Principle," and its implications were huge. He had identified the common link that drives the trends in human affairs, from financial markets to fashion, from politics to popular culture.
Robert Prechter, Jr., president of Elliott Wave International, resurrected the Wave Principle from near obscurity in 1976 when he discovered the complete body of R.N. Elliott's work in the New York Library. Robert Prechter, Jr. and A.J. Frost published Elliott Wave Principle in 1978. The book received enthusiastic reviews and became a Wall Street bestseller. In Elliott Wave Principle, Prechter and Frost's forecast called for a roaring bull market in the 1980s, to be followed by a record bear market. Needless to say, knowledge of the Wave Principle among private and professional investors grew dramatically in the 1980s.
When investors and traders first discover the Elliott Wave Principle, there are several reactions:
  • Disbelief – that markets are patterned and largely predictable by technical analysis alone 
  • Joyous “irrational exuberance” – at having found a “crystal ball” to foretell the future 
  • And finally the correct, and useful response – “Wow, here is a valuable new tool I should learn to use.”
Just like any system or structure found in nature, the closer you look at wave patterns, the more structured complexity you see. It is structured, because nature’s patterns build on themselves, creating similar forms at progressively larger sizes. You can see these fractal patterns in botany, geography, physiology, and the things humans create, like roads, residential subdivisions… and – as recent discoveries have confirmed – in market prices.
Natural systems, including Elliott wave patterns in market charts, “grow” through time, and their forms are defined by interruptions to that growth. 
Here's what is meant by that. When your hands formed in the womb, they first looked like round paddles growing equally in all directions. Then, in the places between your fingers, cells ceased growing or died, and growth was directed to the five digits. This structured progress and regress is essential to all forms of growth. That this “punctuated growth” appears in market data is only natural – as Robert Prechter, Jr., the world's foremost Elliott wave expert and president of Elliott Wave International, says, “Everything that thrives must have setbacks.” 
Basic Elliott Wave PatternThe first step in Elliott wave analysis is identifying patterns in market prices. At their core, wave patterns are simple; there are only two of them: “impulse waves,” and “corrective waves.”
Impulse waves are composed of five sub-waves and move in the same direction as the trend of the next larger size (labeled as 1, 2, 3, 4, 5). Impulse waves are called so because they powerfully impel the market. 
A corrective wave follows, composed of three sub-waves, and it moves against the trend of the next larger size (labeled as a, b, c). Corrective waves accomplish only a partial retracement, or "correction," of the progress achieved by any preceding impulse wave. 
As the figure to the right shows, one complete Elliott wave consists of eight waves and two phases: five-wave impulse phase, whose sub-waves are denoted by numbers, and the three-wave corrective phase, whose sub-waves are denoted by letters.
What R.N. Elliott set out to describe using the Elliott Wave Principle was how the market actually behaves. There are a number of specific variations on the underlying theme, which Elliott meticulously described and illustrated. He also noted the important fact that each pattern has identifiable requirements as well as tendencies. From these observations, he was able to formulate numerous rules and guidelines for proper wave identification. A thorough knowledge of such details is necessary to understand what the markets can do, and at least as important, what it does not do. 
You have only just begun to learn the power and complexity of the Elliott Wave Principle. So, don't let your Elliott wave education end here. Join Elliott Wave International's free Club EWI and access the Basic Tutorial: 10 lessons on The Elliott Wave Principle and learn how to use this valuable tool in your own trading and investing."

I attempted to chart out some waves on SPY and also provided trends and Fibonacci retracements on the S&P 500. Mr. Prechter please comment with your thoughts.

Here is a potential "corrective" wave formation. To attempt a breakdown $SPY needs to break below 107.5 support and retest the 50 day moving average (103.74).

Charts courtesy of Stockcharts.com
Attempting wave patterns from 2007 peak to March 2009 trough. "C" must be confirmed before declaring this move a bear market rally.

The S&P 500 closed at 1,087.68 and is near the 50% retracement level (1,121.44) and 61.8% retracement (1,228.74). The S&P is also close to the downtrend that hits the y-axis around 1,160 and is near July 2008 resistance (1,200). Which number will be hit before we see a correction 1,121, 1,160, 1,200, 1228 or.... 1,576. That would be a great black swan.

Is it time to hedge a potential wave? I know this goes against the Bernanke liquidity trade, but there HAS to be a decent correction at some point! Watch the streaming S&P chart below to see what happens. By the way, visit the Afraid To Trade blog by Corey Rosenbloom for Elliot Wave analysis.

VIX Update: Implied Volatility On Volatility (10/17)

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According to Bloomberg (VIX Posts Worst Losing Streak in Four Years as Dow Tops 10,000 ), the $VIX (Volatility Index) is down 74% from the November 2008 high. It closed at 21.43 on Friday. The $VIX is the forward 30 day implied volatility on S&P 500 index options (Go to: Ten Things Everyone Should Know About the VIX at Vixandmore.com). So if you're worried about market volatility going forward, buying puts on the S&P are CHEAPER than they were 6 months ago. The only problem is they could get cheaper (if appreciation is your main goal). Here is the CBOE VIX Index streaming via freestockcharts.com.

There are also options on VIX futures contracts that you can follow. For a few months now (chart below), implied volatility on the VIX has been higher than 30 day historical volatility. Spikes in $VIX implied volatility have translated into underlying $VIX moves, however the VIX moves translated into either a higher market (late July) or minor sell offs.

Now we have interesting action again in the $VIX, $VIX implied volatility and VIX futures. As of 10/17, VIX Implied Volatility is at 106.59% while VIX Historical Volatility is at 58.42%! That is a decent spread between what the market is implying going forward vs. 30 day historical VIX volatility. Hat tip @smsearsBarrons. Not only that, there's a big spread between VIX put implied volatility and call IV. Ivolatility.com data shows that VIX Put IV is at 111.54% while call IV is at 101.64%. People like those puts, watch the 10/16 Volatility Sonar report. Eventually VIX volatility will sell off (imo) and the $VIX will move, just like the July 22 peak (Put IV was also higher than Call IV at that time). The actual $VIX calculation is hitting lows at 21.43, the October VIX future is at 22.35 while the February contract is at 27.30. Something has to give here, again.

VIX Implied Put/Call Volatility (Courtesy of IVolatility)

For better interpretation and knowledge hit up OptionMonster, VIXandMore, DailyOptionsReport and InvestingWithOptions. If you have a website on volatility put a link in the comment bar, I'd like to see it.

Geithner Speech Video At Buttonwood Gathering 'Fixing Finance' Event

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Secretary Tim Geithner spoke at the Buttonwood Gathering (Fixing Finance) event. You can find it here at Bloomberg.com. It's a 58 minute video.

Robert Shiller: Don't Expect Dramatic Continuation to Rally, Surprised By Momentum and Housing Turn

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At the very end of the video Yale Professor Robert Shiller says:
"My idea is we're kind of bouncing around a resistance level... My price/earnings ratio is around 20 now... You know it's ok to buy stocks but don't expect a dramatic continuation of this".
He's shocked by the market momentum and rebound in home prices. "This is the sharpest turnaround we've seen since 1933". Watch the whole video.

How Goldman Made $3 Billion in Q3: Dylan Ratigan, FICC Revenues (MSNBC Video)

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Hat tip Zerohedge.

Goldman Sachs made $10.02 Billion from trading and principal investments! Fixed income, currency and commodities (FICC) net revenues increased 368% to $5.9 Billion from $1.6 billion a year ago (8/29/2008). These numbers were lower than Q2. I have some good news for the U.S Taxpayer though. From their earnings release.
"On July 22, 2009, the firm repurchased the warrant issued to the U.S. Treasury pursuant to the Treasury’s TARP Capital Purchase Program for $1.1 billion. The U.S. taxpayers’ annualized return on their total investment in the firm was approximately 23%" (Source: Goldman Sachs)

Goldman's Q3 Revenues By Segment (Earnings Release)

Goldman you should come out with a rap album to demand respect in the game.

Hedge Fund Insider Trading Case! (Galleon, New Castle, Intel Capital), Recent Ponzi News 10/16/09

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Hedge fund Galleon is in some trouble for insider trading.
  • Galleon Statement (Reuters)
  • Galleon Busted In $20 Million Insider Trading Case (Zero Hedge)
  • One Of U.S.' Richest Men , 5 Others, Charged In Insider Trading (NPR)
  • Who Cooperated With The FBI On Galleon? (DealBreaker)
  • Insider Trading Arrests Rock Wall Street (Thestreet.com)
  • Hedge-Funder Raj Rajaratnam Got Cranky When People Refused to Partake in His Insider-Trading Scheme (NYMag)
  • GALLEON PRESS CONFERENCE BLOG: FBI Says 'Average' Investor Got Hurt (WSJ)
  • Galleon's Rajaratnam, Others Charged In Insider Case (WSJ)
  • Galleon’s Rajaratnam Charged in Insider Trading Scam (Bloomberg)
  • Hedge Fund Executive Is Charged With Insider Trading (DealBook)

Full report by David Faber at CNBC.com (Six Charged With Hedge Fund Insider Trading)

How about recent ponzi scheme news while I'm at it (I found Indian and Canadian schemers as well, to make the US feel a little bit better). I present to you Madoff aftershocks.
  • SEC Charges Three Florida Men in Alleged $14.3 Million Ponzi Scheme (WSJ)
  • S.F. man accused of 30-year Ponzi scheme (SFGate)
  • Florida man indicted in $20 million Ponzi scheme targeting Harrisburg area (TheSentinel)
  • New Jersey man confesses to $6 million life insurance Ponzi scheme (IFAwebnews)
  • Elk Grove Village man accused of stealing millions from investors in Ponzi scheme (Chicago Tribune)
  • FBI, IRS looking into Canadian Ponzi scheme (MontrealGazette)
  • Detroit Man Indicted in $200 Million Ponzi Scheme (Bloomberg)
  • Mass. Hedge Fund Manager Gets Seven Years For Ponzi Scheme (FINalternatives)
  • Breaking: Alleged Ponzi Schemer Nicholas Cosmo Jailed (WSJ Blogs)
  • Broker accused in SEC complaint of luring elderly into Ponzi scheme (Freep)
  • Second Man Arrested for Fraud in Canada’s Biggest Ponzi Scheme (Bloomberg)
  • Firm booked for duping investors of Rs 1.2 cr (TimesofIndia)
  • Beverly Hills investment advisor pleads guilty in Ponzi scam (LA Times)
  • Riverside County man sentenced to 100 years for operating Ponzi scheme (LA Times)
  • Montana Seeks Assets in Alleged $14M Ponzi Scheme (NY Times)
To keep you updated here is a google news search on "ponzi scheme" during the past month. Wow, so much for ethics classes.

Break Point

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Break Point (Update on California and oil by Gregor.us)

If Google Finance Had a Stock Chart Embed Feature, I'd Use It!

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It would be cool if Google Finance had a stock chart embed feature so I could throw them up on my blog. Kirk and Cartoon Barry are with me on this one too. I see a "link to this chart" feature but no embed. I'd embed the charts every day If I could draw trend lines on them. Google Finance has great charts for stocks and indexes on foreign exchanges, let alone the NYSE/NASDAQ etc. For example here is the Hang Seng Property Index and Henderson Land Development Co out of Hong Kong.

Exact Chart Source at Google Finance

Joe Saluzzi Is Not Buying This Rally On P/E, Q-Ratio (Video)

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Joe Saluzzi of Themis Trading is not buying this rally. Summary of his thoughts, watch the video.
  • If you're looking at a forward P/E over 16, that prices in a vibrant economy, not an economy that is still suffering.
  • Regarding banks: Fed is giving away money for free and they lend it out at 5% (easy money).
  • If the economy is so great, why is the Fed keeping interest rates at 0%?.
  • "I'm betting still that the problems that we have in housing and unemployment and the deficit rising are going to trump all of that".
  • Foreclosed shadow inventory will put pressure on housing.
  • Realistically we have to be 15-20% lower to start. Looking at cyclically adjusted P/E and the Q-Ratio (total price/replacement cost) he sees a 35-40% retracement.
  • The market is not efficient.
Regarding the Q-Ratio, Bill Gross mentioned it in his December 2008 Investment Outlook called Dow 5,000 Redux where he explains it. A corrective wave will come people!

Marcus Millichap's Harvey Green: Commercial Real Estate Update (CNBC, 10/15)

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David Faber challenges Harvey Green of commercial real estate broker Marcus Millichap on CNBC. Here are a few of their national outlook reports from October 2009 on retail, apartments, office, second half medical office, industrial, senior housing. All can be found on their research tab, you have to sign up for free.

Peter Schiff's Thoughts On Dow 10,000, USD, Oil Breakout and Inflation (Video)

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Here is Peter Schiff on Dow 10,000, the US Dollar and an oil breakout. In real terms, measured in purchasing power (US Dollars), the S&P hasn't moved much over the year even with the swings. Look at the USD/SPX chart. It beat holding straight cash though. Pedro also believes that the market could fall in nominal terms or WITH the US Dollar, which would break apart the current inverse relationship. David Tice of the Prudent Bear Fund is also in this camp. Something to keep an eye on... By the way it does look like oil broke above resistance, if $75 sticks. Next up is $85 resistance from early 2008. We'll see if there is real growth attached to this action.

S&P vs. US Dollar Index (Courtesy of Stockcharts.com)

West Texas Intermediate Crude Oil ($WTIC - Courtesy of Stockcharts.com)

Partying Like It's 1999 Again, Dow Hits 10,000 (3/29/1999 CNBC Video)

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The Dow hit 10,000 today. We haven't budged in 10 years. Here is a look back on March 29, 2009 when CNBC reported that magical day. Now a crisis and a trillion dollars later, we were able to reach that level again.

March 29, 1999

October 14, 2009

Stuy Town/Peter Cooper Village Default Risk Updates (Video, Links)

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Remember that other shoe? Here are Manhattan commercial real estate updates:

An 11,000 apartment complex in Manhattan, owned by Tishman Speyer (a unit of BlackRock Inc), could default on it's loans. And it looks like pension funds could lose $600 million. From the video below: The property was bought for $5.4 Billion and financed with a $3 billion first mortgage plus a $1.4 billion mezzanine piece. An equity investor included the Church of England. Real Point said the property is now worth $2.1 billion.

  • Update: Stuy Town Still Screwed (Gothamist)
  • High-Profile Tishman/BlackRock Property in New York in Danger of Default (WSJ.com)
  • NYC housing complex on verge of loan default: report (Reuters)
  • Pension funds stand to lose $600M in Manhattan venture (LA BizJournals)
  • Real estate deal could cost CalPERS $500 million (SacBee)
  • T Minus Four Months Until Stuyvesant Town Defaults (New York Magazine)
  • Church of England could lose in StuyTown (The Deal)
  • Real Estate News: Stuy Town Teeters, Insurers Drop Drywall Victims (WSJ Blogs)
Also, Zero Hedge has an interesting article on the Union Square W Hotel .

Jim Rogers: Inflation Could Be Worse Than Seventies Stagflation (TT Video)

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Jim Rogers was on Tech Ticker a couple days ago. He says inflation going forward could be worse than the seventies.
  • The Government is printing a "stupendous" amount of money.
  • He mentions that there are shortages developing of everything (agriculture, mining products) and capacity constraints.
  • "All of this before has led to higher prices".
  • "The way inflation works is, it starts slow and it gets worse and worse and worse".
  • "The Federal Reserve has laid the groundwork for some serious inflation down the road by printing all this money but so have many other Central Banks."

The seventies had stagflation mainly as a result of shortages from price controls. So prices went up even when the economy was bad.

Explaining the 1970s stagflation (Source: Wikipedia)

"Following Richard Nixon's imposition of wage and price controls on August 15, 1971, an initial wave of cost-push shocks in commodities was blamed for causing spiraling prices. Perhaps the most notorious factor cited at that time was the failure of the Peruvian anchovy fishery in 1972, a major source of livestock feed.[16] The second major shock was the 1973 oil crisis, when the Organization of Petroleum Exporting Countries (OPEC) constrained the worldwide supply of oil.[17] Both resulted in actual or relative scarcity of raw materials. The price controls resulted in shortages at the point of purchase, causing, for example, queues of consumers at fueling stations and increased production costs for industry.[18]"

The deflation argument is still alive and well though (Prechter on 10/6). Aaron Task also mentioned something interesting on Twitter:
"When the Dow 1st hit 10K in '99: total U.S. debt was $24.6T vs $50.8T now, gold was $280 vs $1,070, oil $16.44 vs $74.80 etc. -Peter Bookvar" (Source: @atask)

Hang Seng Property Index Battling 28,000 Level, Tsang Has Bubble Concerns

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Distressed Volatility (仿旧波动) - China Section (中国科)

Switching it up. This for traders at the HKEX (Hong Kong). I was watching a symmetrical triangle form on the Hang Seng Property Index (
HSP quote/chart) on this post and it could be breaking out. It still needs to clear the 28,000 resistance level to prove it has strength to retest 29,000 (August highs). There are risks. Andy Xie thinks Chinese stocks are overvalued and imo the chart does look ripe for an extended pullback at some point. So if HSP fails here and volatility picks up, it could test 26,000. Another risk to the downside is Government intervention. If I was on the long side I'd have puts for protection and to play downside volatility, if it shall arise.

HSP just tested 28,000 and sold off as we speak. There isn't a Hang Seng Property Index ETF so you have to go straight to the source at the 香港交易所.

Hang Seng Property Index (Courtesy of Bloomberg)

Looking at the 5 min chart, it pierced through 28,000 after the lunch break.

30Y Treasury Yields Lower at Resistance, $TLT Up (Live Charts)

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Updates on the 30 Year Treasury yield and $TLT (20+ Treasury ETF). 30Y T-Yields are selling off of a clean downtrend and what looks like 50 day moving average resistance. It could be the "no rate hike" speculation, safe haven buying or the Fed propping up the market. If you know disqus below. Here are a few articles by Bloomberg:

Treasuries Rise on Speculation Rates to Stay Low, Dollar Falls (Bloomberg)
Oct. 13 (Bloomberg) -- Treasuries rose for the first time in three days on speculation the dollar’s decline will spur demand from foreign investors as the Federal Reserve keeps interest rates at a record low through late 2010.
Treasury Bond Rally Fails the Asset-Bubble Test: Caroline Baum (Bloomberg)

TIPS Show Bernanke Isn’t Whipping Inflation Concerns (Bloomberg)

I prefer to watch price action for updates. Here are charts of the CBOE 30 Year Treasury Index and $TLT. Keep an eye on that TLT uptrend, if it breaks here there could be some yield volatility. $TYX would have to break above that downtrend.



Housing: XHB, PHM Calls Positioning Before October Expiration

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Earlier this morning I saw that 15,000 October 15 Calls traded with 4,400 open. $XHB is trading at 15.42.

This is interesting because OptionMonster just came out with a release on Pulte Homes (PHM) showing that the October $11 calls were active. What's up here, levering up or hedging short positions. They got 3 days until expiration.

Options look for pop in Pulte Homes (OptionMonster)

Pre-Earnings Chart Analysis: SPY, VIX, XLK, TLT, XLI, IYT, UUP, GLD, USO (10/12/09)

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Here are charts and technical analysis before major moves occur this week and next. I first charted out sector ETFs individually (Tech:XLK, Energy:XLE, Transports:IYT Industrials:XLI) and then did a 20 day performance comparison.

XLK has had a monster run and is now challenging the September '09 high and early 2008 lows. RSI (strength) is at 61 but has been diverging with price, same with the money flow index. The MACD (momentum) has been diverging with price but is still above zero, meaning the 12dma (faster moving avg) hasn't crossed below the 26dma (slower moving avg). You can also see that XLK is trading in a steep triangle and is near the moment of trend judgment. It did break above that 2 year downtrend and it is currently above the 50dma. IMO, wait for the catalyst. Either we retest the 50d or break out to 24.

Same goes for XLI, but it needs to break above the September 2009 high to reach the next resistance level, 32. Money flow is below 0 at -0.064. IYT has a historical ceiling and a downtrend to break above. MACD is just above zero so watch momentum. What's interesting is the money flow index. It is at -0.0176, hitting levels not seen since June.

XLE looks the best. It just pierced through resistance and if there is a follow through XLE could test 2008 levels, or 62. Money flow and RSI are strong but there has been price divergence.

Looking at 20 day sector performance comps, energy outperformed up 5.88%, tech was up 2.37%, industrials were unchanged while the transports lost -2.38%. Strength must pick up in the transports.

All the rest are self explanatory. The SPY needs to break above near term resistance if it wants to test 117 (July 2008 resistance). The VIX is hitting yearly lows for the third time at 23. I also provided charts of USO, TLT, GLD and UUP. USO is riding oil strength and is brushing up against symmetrical triangle/June resistance. A break above those levels would be interesting. I'd say provide some charts in the comment section but Disqus can't embed pictures. Wack.

XLK (Courtesy of Stockcharts.com)



XLE,XLI,XLK,IYT 20 Day Performance







Doug Kass Has Highest Net Short Position Since February

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Full article can be found at Realmoney Silver by subscription. Remember Kass took the other side of the bull in 2006-7?
Slipping Away From the Herd (RealMoney Silver $)
02:30PM 10/12/09

By Doug Kass

"I see an imbalance of rewards on numerous short positions and an imbalance of risk on the long side.~I am now [am] at my largest net short position since February."

Kudlow vs. Kass 11/27/2006

XLF November 16 Calls Active, 162,000 Contracts Traded (10/12/09)

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Big volume on the XLF (Financial ETF) November 16 Call today. Over 162,000 calls traded with 27,206 open. You can see blocks of 48,000+ at both 0.46 and 0.49 from my OptionsXpress screen shot. Will the big banks benefit from yield curve induced net interest margins with lower than expected write downs? Possibly security write ups? We'll see. Traders can cash out with profits if XLF goes above 16.46-16.49, or if call volatility spikes by November expiration. Implied volatility is at 39 and historical is at 31.35 from the ISE.

XLF November 16 Call (Source: Optionsxpress)

Technically XLF is testing the downtrend started in October 2007. If the market buys the numbers and guidance, it could break out of the official downtrend and test $17.5+. If it fails...

XLF (Courtesy of Stockcharts.com)

I'm not sure of the DNA makeup of the trade but Jon Najarian thinks institutions are betting on higher prices. It's funny that our financial system collapsed less than a year ago... But I guess follow the dough! At some point there has to be a volume explosion, good luck.

More information:
Bullish traders pile into financial ETF (OptionMonster)
Monday Options Recap: Fred Ruffy on SeekingAlpha
Options Update: XLF, ENER, NBR, MGM, QCOM, AYE & TIBX (OptionsInsider)

Latvia's Budget, Mortgage Plan, CDS, EUR/LVL etc (10/12/09 Updates)

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Thought I'd update you with links on Latvia situation (10/12/09) and provide a live Euro/Lat currency chart.

Latvia default risk jumps to month high on donor budget dispute (BalticBusinessNews)
Swedish banks downplay Latvian threat (Risk.net)
UPDATE 2-Latvia says agreed to cut budget deficit for EU/IMF (Reuters)
Latvia agrees budget cut goal (BBC.co.uk)
Latvia Mulls Budget Cuts to Appease Bailout Donors (Bloomberg)
Latvia – The Insanity Continues (iStockAnalyst)
Latvian Employers' Confederation: economy yet to reach the lowest point (baltic-course.com)

EUR/LVL (via ForexPros.com)

ForexProsForex Charts Powered by Forexpros.com - The Forex Trading Portal.

QQQQ-to-SPY Underperformed IWM-to-SPY Late July-October 2009 (Chart)

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I'm comparing the 2 Month and 20 day performance between QQQQ/SPY and IWM/SPY as ratios. From Yahoo Finance QQQQ has a 5 year beta of 1.12 and IWM 1.24. The beta (β) of a stock or index is a number describing the relation of its returns with that of the financial market as a whole or S&P 500 and in this case SPY (more at Wikipedia). When the breadth thrust launched the market in early March, QQQQ dominated the market technically and pulled up SPY and DIA (Dow Industrials ETF) during moments of indecision. Examples:

QQQQ Testing 200 Day Moving Average $33.69, Bulls Are Not Backing Down
(May 12)
SPY, DIA Hanging Onto QQQQs 200 Day Support Level (May 27)

Now I'm adding IWM (Russell 2000 Small Cap ETF). I charted out the performance of QQQQ/SPY and IWM/SPY from the most recent QQQQ/SPY peak in late July, or 2 months and 20 days ago. I saw a divergence between QQQQ/SPY and IWM/SPY performance since IWM/SPY made a higher high and QQQQ/SPY made a lower high. In numbers, QQQQ underperformed SPY by -2.08% while IWM outperformed SPY by 2.31%. Why didn't QQQQ's beta give it powers to overpower SPY during the past 3 months? Does Tech know something? How will the IWM:SPY:QQQQ gap close.. It's a conspiracy.

QQQQ-SPY & IWM-SPY (Courtesy of Stockcharts.com)

David Tice: S&P Going to 400, US Dollar Going Below 65!

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Every bull's best friend, David Tice, was on Bloomberg a couple days ago. Not only does he think the market will tank, he also thinks the US Dollar Index is headed below 65. It's interesting that he thinks the US Dollar will fall with deflation. But a Dollar crisis could kill it.
"The stock market has a long way to fall because GDP is going to fall, we're going to have to work off debt, unfortunately we see a funding crisis down the road, interest rates are going to have to go higher, the Dollar is likely to go lower. We're in a heck of a mess here, and in fact we're in a mess globally."

"I think stated unemployment could easily go to 14-15% or so. GDP could decline potentially 10-15% down the road."

LCCMX Chart Testing 50 Day, Diverging With RSI, MACD (10/09/09)

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My last post was "Leader Capital's John Lekas Sees Dow 6,300, Municipal Mergers" so why not chart out his mutual fund: LCCMX (Leader Short Term Bond Fund). It is up 13% from the March lows. It is now on the 50 day moving average and RSI and MACD are near the mid points waiting for direction. What is interesting is the divergence between price and RSI and MACD .

LCCMX (Leader Short Term Bond Fund) Courtesy of Stockcharts.com

Current Yield is 4.23%, Annual Turnover: 211%, Net Expenses 1.93% (*looks like 1.35 see comments) and the top 10 holdings (mostly floating rate notes it looks like) with % allocation and maturity are as follows (data as of 8/31 from Morningstar):

Freeport-Mcmoran Copper & Gold FRN: 3.25%, 4/1/2015
Amer Honda Fin Corp Mtn Be144a 144A FRN: 2.80%, 6/2/2011
Natl City Bk Cleve Sub Mtn Be FRN: 2.44%, 6/7/2017
BANK AMER CHRLT NC MTN: 2.32%, 6/15/2016
Fifth Third Bancorp FRN: 2.26%, 12/20/2016
HSBC FINANCE CORP: 2.15%, 4/24/2012
Goldman Sachs Grp FRN: 2.05%, 3/22/2016
General Elec Cap FRN: 1.89%, 12/20/2016
Principal Life Income Fd Mtn FRN: 1.78%, 11/15/2010
GOLDMAN SACHS GROUP: 1.62%, 9/29/2014

The guy is betting on the short end of the curve and against Muni's and the equity markets. The fund is heavily weighted toward financials and it's floating, a hedge on interest rates? Read his July conference call summary.

LCCMX in the news:
Fund Managers Bracing for a Sell-Off (BusinessWeek) - 10/5/09
Eight Funds That Scream 'Dump Me!' (Morningstar) - 9/7/09

Leader Capital's John Lekas Sees Dow 6,300, Municipal Mergers

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John Lekas of Leader Capital is a bear and expects the Dow to hit 6,300 by the end of 2009 and 4,200 by the end of 2011. Going "below the double dip" on weak earnings on the top and bottom line. He thinks unemployment will be a drag on the economy [mentioning that 785,000 jobs were lost using the U6 data point, not the 265,000 number promoted] and that number will get worse, "26 to 27 million people out of work, that's not going to work, and until that number gets better we will not see a recovery".

He also thinks in-organic growth from extraordinary items will drive earnings going forward (asset sales etc.) but consolidations, mergers and refinancings recently have helped. Michael Cuggino of Permanent Portfolio Funds took the opposite view. You have to give credit to the last standing bears.

I thought what John said about municipalities was the most interesting part.
"I think it will get to the point where we see Municipalities merge in order to create efficiencies."

I did chart analysis on LCCMX right after this post here.

Ht BloggingStocks

Updates On Latvia's Distressed Situation, Soros Has Words

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Soros urges EU to do more to bail out Latvia (AFP)
"STOCKHOLM — US billionaire George Soros on Saturday called on the European Union to do more to help Latvia's hard-hit economy, expected to retract by an EU-worst 18 percent this year."

Latvia Trying To Reach Agreement With Donors: PM (RTTNews)
"Latvia is working on additional measures to reach an agreement with international donors, the premier's office said Friday.."

Soros says EU "wrong" to push austerity on Latvia (Reuters)
STOCKHOLM (Reuters) - Billionaire investor George Soros blamed the European Union on Saturday for not doing enough to help Latvia, one of the bloc's most damaged economies, recover from the financial crisis and return to growth."

IMF Wraps Up Mission In Latvia, Says Talks Were 'Fruitful' (WSJ/DJ)

WASHINGTON (Dow Jones)--The International Monetary Fund said Friday its staff had "fruitful" discussions with Latvian authorities over the country's 2010 budget plans during a mission to the beleaguered Baltic country."

Latvia austerity steps and budget cuts (onet.pl)
Latvia's appalling currency choice (Financial Times, 10/9/09)
Latvia 'to find more budget cuts' (BBC News)
UPDATE 2-Latvia eyes cuts for agreement with lenders-PM (Forbes.com)
WRAPUP 2-Sweden slams Latvia mortgage plan, Latvia seeks cuts (10/8, Forbes)
INTERVIEW: Latvian Home Bill Would Hurt Recovery - Swedbank (WSJ/DowJones)
CDS On Nordic Financials Widen October 07, 2009 (DerivativesWeek (subscription)
Fitch: Latvia Economy To Contract 18% In 2009, 4% In 2010 (WSJ)

Serious stuff... If it gets serious.

Santelli, Iuorio Debate The USD, Rick Mentions Latvia (10/7)

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Rick Santelli and Jim Iuorio debate about the Dollar's action on CNBC. Rick also mentions Gold and the situation in Latvia, which DiVo has been watching..

Updates On Latvia's Mortgage Plan, Budget, Currency and Sweden (10/8)
Latvian Lat: Auction Fails, Speculation of Devaluation ($LVL)

Icahn: Good Time To Short REITs, Cautious On High Yield Debt But Likes Internet Advertising and Selective Bankruptcy Plays

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Carl was featured on CNBC with Becky Quick. Some of his thoughts on shorting the REITs, mispriced high yield debt, market schizophrenia, advertising on the internet, bankruptcy opportunities and risk of double dip. More on Icahn Enterprises later ($IEP). Hopefully he was well hedged on MOT, WCI, YHOO and minted money on 2008 volatility. Looks like CI gave up on his blog.

Facebook's Mark Zuckerberg Interview With Henry Blodget (10/6/09)

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Henry Blodget of The Business Insider interviewed Mark Zuckerberg, the founder of Facebook. He talks about what he was doing in his dorm room at the time, coming to the Valley and gives three keys to personal success.

Embedded courtesy of The Business Insider.

Zero Hedge Featured in New York Magazine

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Read a 7 page article about financial blog Zero Hedge in the New York Magazine.

Link: The Dow Zero Insurgency

Bernanke Speech: Balance Sheet Update 10/8/09 (Speech, Slides, Video)

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I put the whole speech up here why not. The full speech video can be found at Bloomberg.com. The long bond and $TLT sold off today. If Treasuries come under pressure it will be interesting to see how gold and the S&P react. By the way: Ron Paul Calls for Delay to Bernanke Confirmation Hearing (WSJ).

Chairman Ben S. Bernanke
At the Federal Reserve Board Conference on Key Developments in Monetary Policy, Washington, D.C.

October 8, 2009

The Federal Reserve's Balance Sheet: An Update

To fight a recession, the standard prescription for a central bank is to lower its target short-term interest rate, thereby easing financial conditions and supporting economic growth. In the current downturn, however, the Federal Reserve has faced two historically unusual constraints on policy. First, the financial crisis, by increasing credit risk spreads and inhibiting normal flows of financing and credit extension, has likely reduced the degree of monetary accommodation associated with any given level of the federal funds rate target, perhaps significantly. Second, since December, the targeted funds rate has been effectively at its zero lower bound (more precisely, in a range between 0 and 25 basis points), eliminating the possibility of further stimulating the economy through cuts in the target rate. To provide additional support to the economy despite these limits on traditional monetary policy, the Federal Open Market Committee (FOMC) and the Board of Governors have taken a number of actions and initiated a series of new programs that have increased the size and changed the composition of the Federal Reserve's balance sheet.

I thought it would be useful this evening to review for you the most important elements of the Federal Reserve's balance sheet, as well as some aspects of their evolution over time. As you'll see, doing so provides a convenient means of explaining the steps the Federal Reserve has taken, beyond conventional interest rate reductions, to mitigate the financial crisis and the recession, as well as how those actions will be reversed as the economy recovers. I laid out some of these points in April at a conference sponsored by the Federal Reserve Bank of Richmond, but a lot has happened in the intervening period and so an update seems timely.1

For those of you who might be interested in learning more about the Federal Reserve's policy strategy, by the way, an excellent source of information is a feature of the Board's website titled "Credit and Liquidity Programs and the Balance Sheet."2 This source provides extensive and regularly updated information on our programs and goes well beyond the basic balance sheet data that we publish every week.3

To get started, slide 1 provides a bird's eye view of the Federal Reserve's balance sheet as of September 30, the quarter end, with the corresponding data from just before the crisis for comparison. As you can see, the assets held by the Federal Reserve currently total about $2.1 trillion, up significantly from about $870 billion before the crisis. The slide shows the principal categories of assets we hold, grouped (as I will explain) so as to correspond to the various types of initiatives we've taken to address the crisis. The liability side of the balance sheet, also summarized in slide 1, primarily consists of currency (Federal Reserve notes) and bank reserve balances (funds held in accounts at the Federal Reserve by commercial banks and other depository institutions). Later in my remarks, I will discuss the relationship between Federal Reserve liabilities and broader measures of the money supply. I will also discuss ways we can manage the link between the size of the Federal Reserve's balance sheet and the broader money supply during the transition back to a more familiar framework for monetary policy. Our capital, the difference between assets and liabilities, is about $50 billion.

The Asset Side of the Federal Reserve's Balance Sheet
Let's now look at the balance sheet in more detail, beginning with the asset side. For decades, the Federal Reserve's assets consisted almost exclusively of Treasury securities. Since late 2007, however, the share of our assets made up of Treasury securities has declined, while our holdings of other financial assets have expanded dramatically. As slide 1 shows, putting aside the miscellaneous "other assets" category, which includes such diverse items as foreign exchange reserves and the buildings owned by the Federal Reserve System, the assets on the Federal Reserve's balance sheet can be usefully grouped into four categories:
  • (1) short-term lending programs that provide backstop liquidity to financial institutions such as banks, broker-dealers, and money market mutual funds;
  • (2) targeted lending programs, which include loans to nonfinancial borrowers and are intended to address dysfunctions in key credit markets;
  • (3) holdings of marketable securities, including Treasury notes and bonds, the debt of government-sponsored enterprises (GSEs) (agency debt), and agency-guaranteed mortgage-backed securities (MBS); and
  • (4) emergency lending intended to avert the disorderly collapse of systemically critical financial institutions. I will say a bit more about each of these in turn.
Short-Term Lending Programs for Financial Institutions
The breakdown of the first category of assets--short-term lending programs for financial institutions--is shown on slide 2. As you can see, these assets currently total about $264 billion, which is about 12 percent of the assets on the Federal Reserve's balance sheet. This category of assets consists mainly of loans made directly or indirectly to sound financial institutions. Such loans are fully secured by collateral and, in almost all cases, by recourse to the borrowing institution, and are for maturities no greater than 90 days. Thus, they involve very little credit risk; the Federal Reserve has suffered no losses on any of these loans.

From its beginning, the Federal Reserve, through its discount window, has provided credit to depository institutions to meet unexpected liquidity needs, usually in the form of overnight loans. The provision of short-term liquidity is, of course, a longstanding function of central banks, and--as we know from Bagehot and earlier authors--a principal tool for arresting financial panics.4 Indeed, when short-term funding markets deteriorated abruptly in August 2007, the Federal Reserve's first response was to try to increase the liquidity available to the market by lowering the rate charged for discount window loans and by making it easier for banks to borrow at term. However, as in some past episodes of financial distress, banks were reluctant to rely on discount window credit, frustrating the Federal Reserve's efforts to enhance liquidity. The banks' concern was that their recourse to the discount window, if it somehow became known, would lead market participants to infer weakness--the so-called stigma problem. To address this issue, in late 2007, the Federal Reserve established the Term Auction Facility (TAF), which, as the name implies, provides fixed quantities of term credit to depository institutions through an auction mechanism. The introduction of this facility seems largely to have solved the stigma problem, partly because the sizable number of borrowers provides a greater assurance of anonymity, and possibly also because the three-day period between the auction and auction settlement suggests that the facility's users are not using it to meet acute funding needs on a particular day. As slide 2 shows, as of September 30, conventional discount window loans totaled $29 billion, and funds auctioned through the TAF totaled $178 billion. These programs, along with similar lending by other major central banks, appear to have helped stabilize the financial system here and abroad by ensuring depository institutions access to ample liquidity. In particular, increases in Federal Reserve loans to banks have been associated with substantial improvements in interbank lending markets, as reflected, for example, in the sharp declines in the spread between the London interbank offered rate, or Libor, and measures of expected policy rates.

Like depository institutions in the United States, foreign banks with large dollar-funding needs have also experienced powerful liquidity pressures over the course of the crisis. This unmet demand from foreign institutions for dollars was spilling over into U.S. funding markets, including the federal funds market, leading to increased volatility and liquidity concerns. As part of its program to stabilize short-term dollar-funding markets, the Federal Reserve worked with foreign central banks--14 in all--to establish what are known as reciprocal currency arrangements, or liquidity swap lines. In exchange for foreign currency, the Federal Reserve provides dollars to foreign central banks that they, in turn, lend to financial institutions in their jurisdictions. This lending by foreign central banks has been helpful in reducing spreads and volatility in a number of dollar-funding markets and in other closely related markets, like the foreign exchange swap market. Once again, the Federal Reserve's credit risk is minimal, as the foreign central bank is the Federal Reserve's counterparty and is responsible for repayment, rather than the institutions that ultimately receive the funds; in addition, as I noted, the Federal Reserve receives foreign currency from its central bank partner of equal value to the dollars swapped. Because the loan to the foreign central bank, as well as the repayment of principal and interest, are set in advance in dollar terms, the Federal Reserve also bears no exchange rate risk in these transactions. Slide 2 shows the current value of outstanding swap lines at $57 billion, down from $554 billion at the end of last year, reflecting the marked improvement in dollar-funding markets across the globe.

In March 2008, following a sharp deterioration in funding conditions and the near failure of the investment bank Bear Stearns, the Federal Reserve opened up its short-term lending facilities to primary dealers.5 Discount window lending and swap lines are part of the Federal Reserve's standard toolkit and are recognized in the Federal Reserve Act with provisions specifically identifying and authorizing each practice. However, the extension of credit to primary dealers is not authorized by the act in routine circumstances. To make these loans, which we judged to be necessary for the stability of the financial system and of the economy, the Board of Governors invoked general emergency lending authority provided by section 13(3) of the act, which allows the Federal Reserve to make secured loans under "unusual and exigent" circumstances to any individual, partnership, or corporation. Using this authority, the Federal Reserve made short-term collateralized loans available to primary dealers through an analogue to the discount window called the Primary Dealer Credit Facility (PDCF). In serving as a lender of last resort to this important class of financial institutions, the Federal Reserve supported broader market and systemic stability. Reflecting a gradual improvement in financial markets, outstanding PDCF credit dropped to zero this past spring. For similar reasons, the Federal Reserve also invoked the 13(3) authority to provide liquidity to another type of financial institution, money market mutual funds. The money fund industry suffered a significant run in September 2008 after a prominent fund "broke the buck"--that is, was unable to maintain a net asset value of $1 per share. Together with an insurance program offered by the Treasury, the Federal Reserve's lender-of-last-resort activity helped to end the run and stabilize the money funds. The final row of slide 2 shows that credit outstanding under the Federal Reserve programs aimed at stopping the run on money funds has also dropped essentially to zero.6

The unstinting provision of liquidity by the central bank is crucial for arresting a financial panic. By the same token, the pricing and terms of central bank lending facilities should discourage usage and encourage firms to return to the private markets when the panic subsides. Slide 2 shows that this has been the case. Short-term lending to financial institutions was zero in June 2007, just before the crisis began, and exceeded $1.1 trillion at the end of last year. Currently, as I mentioned, this category has fallen to about $264 billion, a decline of more than 75 percent since the turn of the year. We expect this trend to continue as markets improve.

Targeted Lending to Address Credit Market Dysfunction
The second category of assets on the Federal Reserve's balance sheet, shown on slide 3, consists of targeted lending programs aimed at improving the functioning of certain key credit markets, thereby providing critical support to the economy. Unlike the first category of assets, some of these loans are to nonfinancial borrowers. As the slide shows, this category comprises the Commercial Paper Funding Facility (CPFF) and the Term Asset-Backed Securities Loan Facility (TALF). The current amount of credit outstanding under these programs is about $84 billion, or four percent of the assets held by the Federal Reserve.

The commercial paper market is an important source of short-term funding for both financial and nonfinancial firms in the United States. In September 2008, the collapse of the investment bank Lehman Brothers set off a chain reaction: The money fund that broke the buck, to which I just alluded, did so because of its losses on Lehman Brothers commercial paper. Because money market funds are major investors in commercial paper, the run on the money funds that ensued also severely disrupted the commercial paper market. During this period, commercial paper rates spiked, even for the highest-quality firms. Moreover, most firms were unable to borrow for terms longer than a few days, exposing both the borrowing firms and the lenders to significant rollover risk. The Federal Reserve's CPFF addressed this risk by offering to lend at a term of three months, at a rate above normal market rates plus upfront fees, to high-quality commercial paper issuers. This program appears to have been quite successful. Since the CPFF was created, commercial paper spreads have returned to near-normal levels, and--as anticipated--borrowings from the CPFF have declined sharply, from $334 billion at the turn of the year to less than $50 billion today.

Before the crisis, securitization markets were an important conduit of credit to the household and business sectors; some have referred to these markets as the "shadow banking system." Securitization markets (other than those for mortgages guaranteed by the government) were virtually shut down in the crisis, eliminating an important source of credit.7 To address this concern, the Federal Reserve, in conjunction with the Treasury, launched the TALF. Under the TALF, eligible investors may borrow to finance purchases of the AAA-rated tranches of certain classes of asset-backed securities. The program originally focused on credit for households and small businesses, including auto loans, credit card loans, student loans, and loans guaranteed by the Small Business Administration. More recently, we have added commercial mortgage-backed securities to the program, with the goal of mitigating a severe refinancing problem in that sector.

The TALF has had some success in restarting securitization markets. Rate spreads for asset-backed securities have declined substantially, and we are seeing some market activity that does not use the facility. Like our other programs, the TALF carries little credit risk for the Federal Reserve, because we lend investors less than the value of the collateral and because capital from the Treasury provides additional loss-absorption capacity. Unlike the other programs, TALF credit outstanding has increased over time, as the loans made under this program are for terms ranging from three to five years.

Relative to the Federal Reserve's short-term lending to financial institutions, the CPFF and the TALF are rather unconventional programs for a central bank. I believe they are justified by the extraordinary circumstances of the past year and by the need for the central bank's crisis response to reflect the evolution of financial markets. Nonbank sources of credit, such as the commercial paper market and the securitization markets, are critical to the U.S. economy, especially compared with the more bank-centric economies of many foreign countries. By backstopping these markets, the Federal Reserve has helped normalize credit flows for the benefit of the economy.

Purchases of Longer-Term, Marketable Securities
The third major category of assets on the Federal Reserve's balance sheet is holdings of high-quality, marketable securities--specifically, Treasury securities, agency debt, and agency-backed MBS. As shown by slide 4, these holdings currently total about $1.6 trillion, or about 75 percent of Federal Reserve assets. By way of comparison, slide 4 also shows that, prior to the crisis, the Federal Reserve held $791 billion in securities, which was about 90 percent of its assets, and that all of these securities were Treasury obligations.

Even as other categories of assets shrink, Federal Reserve holdings of longer-term securities are set to continue to rise in the near term and will increasingly dominate the asset side of the balance sheet. As slide 4 shows, our holdings of securities declined from the period before the crisis to the beginning of this year. The Federal Reserve announced in November 2008 that it would begin to purchase agency debt and agency MBS; then in March, it announced plans to increase such purchases to as much as $1.25 trillion in agency-backed MBS and $200 billion in agency debt, and also announced plans to buy up to $300 billion in Treasury securities.8 We recently indicated that we expect to purchase the full $1.25 trillion of agency-backed MBS announced in March.9 The Treasury purchase program is being completed this month, while the purchases of agency securities will be executed by the end of the first quarter of 2010. Note, incidentally, that the Federal Reserve's purchases of Treasury securities have served only to bring its holdings of U.S. Treasury debt back to roughly the level of before the crisis. The principal goals of our recent security purchases are to lower the cost and improve the availability of credit for households and businesses. As best we can tell, the programs appear to be having their intended effect. Most notably, 30-year fixed mortgage rates, which responded very little to our cuts in the target federal funds rate, have declined about 1-1/2 percentage points since we first announced MBS purchases in November, helping to support the housing market.

Support for Specific Institutions
In addition to the programs I have discussed, the Federal Reserve has provided financing directly to specific systemically important institutions. In particular, with the full support of the Treasury, we used our emergency lending powers to facilitate the acquisition of Bear Stearns by JPMorgan Chase & Co. and also to prevent the imminent default of the insurance company AIG. Slide 5 summarizes the amount of credit outstanding from these episodes.

From a credit perspective, these emergency loans obviously carry more risk than traditional provisions of central bank liquidity. Two observations on this point are worth making: First, these loans amount to less than five percent of the Federal Reserve's balance sheet. Thus, Federal Reserve loans that are collateralized by riskier securities are quite small compared with our holdings of assets with little or no credit risk. Second, and more important, these financial risks were the result of actions taken to avert what likely would have been a substantial further intensification of the financial crisis, with potentially dire economic consequences.

All that said, we undertook these operations with great discomfort and only because the United States has no workable legal framework for winding down systemically critical financial institutions in a way that would allow firms to fail and their creditors to lose money without inflicting massive damage on the financial system. The Administration and other regulatory agencies have joined the Federal Reserve in calling on the Congress to develop a special resolution regime for systemically critical nonbank financial institutions, analogous to one already in place for banks, that could be invoked when the impending failure of such institutions threatens financial stability. The rules governing such a regime should spell out as precisely as possible the role that the Congress expects the Federal Reserve to play in such resolutions.

The Liability Side of the Federal Reserve's Balance Sheet
Having reviewed the main categories of assets on the Federal Reserve's balance sheet, let me touch briefly on the liability side (slide 6). The two main components of our liabilities are Federal Reserve notes (that is, paper currency) and reserves held at the Federal Reserve by depository institutions. In addition, as the government's fiscal agent, the Federal Reserve holds Treasury deposits.

The amount of currency in circulation is determined by the public's demand. The "public" here includes non-U.S. residents, as, by some estimates, more than one-half of U.S. currency by value is held outside the country. Banks are required to deposit with the Federal Reserve a certain quantity of reserves, which depends on the amount of customer deposits that the banks hold.10 Reserves exceeding the required amounts are called excess reserves. As you can see from slide 6, the large majority of bank reserves are currently excess reserves.

Effectively, the Federal Reserve funds its lending and securities purchases primarily through the creation of bank reserves. As you can see, the quantity of bank reserves held at the Federal Reserve has risen dramatically as the Federal Reserve's balance sheet has expanded, and reserves are likely to continue to grow as the Federal Reserve purchases additional agency-backed securities. Currency and bank reserves together are known as the monetary base; as reserves have grown, therefore, the monetary base has grown as well. However, because banks are reluctant to lend in current economic and financial circumstances, growth in broader measures of money has not picked up by anything remotely like the growth in the base. For example, M2, which comprises currency, checking accounts, savings deposits, small time deposits, and retail money fund shares, is estimated to have been roughly flat over the past six months.

Large increases in bank reserves brought about through central bank loans or purchases of securities are a characteristic feature of the unconventional policy approach known as quantitative easing. The idea behind quantitative easing is to provide banks with substantial excess liquidity in the hope that they will choose to use some part of that liquidity to make loans or buy other assets. Such purchases should in principle both raise asset prices and increase the growth of broad measures of money, which may in turn induce households and businesses to buy nonmoney assets or to spend more on goods and services. In a quantitative-easing regime, the quantity of central bank liabilities (or the quantity of bank reserves, which should vary closely with total liabilities) is sufficient to describe the degree of policy accommodation.

Although the Federal Reserve's approach also entails substantial increases in bank liquidity, it is motivated less by the desire to increase the liabilities of the Federal Reserve than by the need to address dysfunction in specific credit markets through the types of programs I have discussed. For lack of a better term, I have called this approach "credit easing."11 In a credit-easing regime, policies are tied more closely to the asset side of the balance sheet than the liability side, and the effectiveness of policy support is measured by indicators of market functioning, such as interest rate spreads, volatility, and market liquidity. In particular, the Federal Reserve has not attempted to achieve a smooth growth path for the size of its balance sheet, a common feature of the quantitative-easing approach.

Exit Strategy
My colleagues at the Federal Reserve and I believe that accommodative policies will likely be warranted for an extended period. At some point, however, as economic recovery takes hold, we will need to tighten monetary policy to prevent the emergence of an inflation problem down the road. Looking at the Federal Reserve's balance sheet is useful, once again, in helping to understand key elements of the Federal Reserve's exit strategy from its current policies (slide 7).

As we just saw in slide 6, banks currently hold large amounts of excess reserves at the Federal Reserve. As the economy recovers, banks could find it profitable to be more aggressive in lending out their reserves, which in turn would produce faster growth in broader money and credit measures and, ultimately, lead to inflation pressures. As such, when the time comes to tighten monetary policy, we must either substantially reduce excess reserve balances or, if they remain, neutralize their potential effects on broader measures of money and credit and thus on aggregate demand and inflation.

To some extent, excess reserves will automatically contract as improving financial conditions lead to reduced use of our special lending facilities and, ultimately, to their closure. Indeed, as I have already noted, the amount of credit outstanding in the first two categories of assets (short-term lending to financial institutions and targeted lending programs) has already declined substantially, from about $1.5 trillion at the beginning of the year to about $350 billion. In addition, reserves could be reduced by about $100 billion to $200 billion each year over the next few years as securities held by the Federal Reserve mature or are prepaid.

However, even if our balance sheet stays large for a while, we have two broad means of tightening monetary policy at the appropriate time--paying interest on reserve balances and taking various actions that reduce the stock of reserves. In principle, we could use either of these approaches alone; however, to ensure effectiveness, we likely would use both in combination.

The Congress granted us authority last fall to pay interest on banks' balances at the Federal Reserve. Currently, we pay banks an interest rate of 1/4 percent. When the time comes to tighten policy, we can raise the rate paid on reserve balances as we increase our target for the federal funds rate. In general, banks will not lend funds in the money market at an interest rate lower than the rate they can earn risk-free at the Federal Reserve. Moreover, they should compete to borrow any funds that are offered in private markets at rates below the interest rate on reserve balances because, by so doing, they can earn a spread without risk. Thus, the interest rate that the Federal Reserve pays should tend to put a floor under short-term market rates. Raising the rate paid on reserve balances also discourages excessive growth in money or credit, because banks will not want to lend out their reserves at rates below what they can earn at the Fed. Considerable international experience suggests that paying interest on reserves is an effective means of managing short-term market rates. For example, the European Central Bank (ECB) allows banks to place excess reserves in an interest-paying deposit facility. Even as the ECB's liquidity operations have substantially increased its balance sheet, the overnight interbank rate has remained at or above the ECB's deposit rate. The Bank of Japan, the Bank of Canada, and several other foreign central banks have also used their ability to pay interest on reserves to maintain a floor under short-term market rates.

Although, in principle, the ability to pay interest on reserves should be sufficient to allow the Federal Reserve to raise interest rates and control money growth, this approach is likely to be more effective if combined with steps to reduce excess reserves. I will mention three options for achieving such an outcome.

First, the Federal Reserve could drain bank reserves and reduce the excess liquidity at other institutions by arranging large-scale reverse repurchase agreements (reverse repos) with financial market participants, including banks, the GSEs, and other institutions. Reverse repos, which are a traditional and well-understood tool of monetary policy implementation, involve the sale by the Federal Reserve of securities from its portfolio with an agreement to buy the securities back at a slightly higher price at a later date. Reverse repos drain reserves as purchasers transfer cash from banks to the Fed. Second, using the authority the Congress gave us to pay interest on banks' balances at the Federal Reserve, we can offer term deposits to banks, roughly analogous to the certificates of deposit that banks offer to their customers. Bank funds held in term deposits at the Federal Reserve would not be available to be supplied to the federal funds market. Third, the Federal Reserve could reduce reserves by selling a portion of its holdings of long-term securities in the open market. Each of these policy options would help to raise short-term interest rates and limit the growth of broad measures of money and credit, thereby tightening monetary policy.

Overall, the Federal Reserve has a wide range of tools for tightening monetary policy when the economic outlook requires us to do so. We will calibrate the timing and pace of any future tightening, together with the mix of tools, to best foster our dual objectives of maximum employment and price stability.

By using our balance sheet, the Federal Reserve has been able to overcome, at least partially, the constraints on policy posed by dysfunctional credit markets and by the zero lower bound on the federal funds rate target. By improving credit market functioning and adding liquidity to the system, our programs have provided critical support to the financial system and the economy. Moreover, we have carried out these programs responsibly, with minimal credit risk and with close attention to the exit strategy. Our activities have resulted in substantial changes to the size and composition of our balance sheet. When the economic outlook has improved sufficiently, we will be prepared to tighten the stance of monetary policy and eventually return our balance sheet to a more normal configuration.

Source: Federal Reserve.gov

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